Repo Rate: Meaning, working and its effect on home loans
The Reserve Bank of India implements several macroeconomic policies and mechanisms to achieve economic equilibrium. The repo rate is one such tool that plays a crucial role in the Indian economy and directly impacts the lending market. RBI revises this rate as a pro-growth measure to keep the money market stable from time to time.
For instance, since March 2020, RBI has slashed the repo rate by 115 points to facilitate growth. However, it is also necessary for borrowers to understand this concept in detail to study the current market condition and its effects on borrowers.
First, individuals should know the definition of this rate before assessing its different mechanisms.
What is the repo rate?
A repo rate is an interest rate at which RBI lends money to other financial institutions in case of a shortage of funds. It is a major monetary policy to control inflation in the market.
Typically, this repo rate helps in deciding the interest rates of loans and other savings schemes. Hence, home loan interest rates depend on these rates and change with market scenario.
It works exactly opposite of a reverse repo rate. The reverse repo rate is a rate at which commercial, financial institutions park excess funds with RBI overnight to earn interest.
The current repo rate stands at 4%, in contrast, to reverse repo rate of 3.35%.
How does the repo rate work?
Conventionally, the Monetary Policy Committee under RBI holds a quarterly meeting to decide the repo rate. This rate usually works in two separate ways, as mentioned below.
- High rate regime
In this instance, RBI hikes the repo rate wherein financial institutions feel discouraged to borrow from RBI due to a higher cost. Simultaneously, the reverse repo rate is also set higher in accordance with the repo rate, encouraging financial institutions to park their money with RBI.
- Low rate regime
Conversely, in a low rate regime, the RBI lowers the repo rate, which entices financial institutions to borrow more at an affordable cost. Similarly, the lower reverse repo rate puts off financiers to keep their money with the RBI as it would yield less incentive.
Based on these two modules, the RBI controls the market and money supply through repo rate.
Repo rate: monetary policy to control inflation and growth
The monetary policies of RBI primarily aim at keeping inflation in check and maintain a healthy ratio of liquidity in the money market. A high repo rate and reverse repo rate result in less money available in market because –
- The borrowing cost is more for financial institutions
- An incentive to park funds with RBI is higher
Such a measure helps in cooling off an overheating economy when inflation is high.
On the contrary, when inflation is under control, RBI lowers the repo rate and reverse repo rate so that –
- Financial institutions can obtain funds at lower rates and extend the same benefits to borrowers
- Such financiers are less likely to lend to the RBI on account of lower yields
It injects liquidity in the market, leaving more funds for entrepreneurs and consumers.
Thus, the repo rate controls the economy and also affects interest rates on different loan products, including a home loan. Hence, borrowers, new and existing ones, should keep a close tab on this rate to make their borrowing beneficial and cost-effective.
Effects of repo rate on home loan borrowers
As per RBI guidelines, the interest rates extended by different financial institutions must be linked with an external benchmark like the repo rate. Lending institutions decide the lending cost percentage after adding a spread on this rate. Hence, individuals availing of a housing loan linked with repo rate are likely to get affected by any change in this rate.
For instance, during a repo rate cut, a home loan interest rate tends to fall, and a higher repo rate increases the interest rate of a home loan. It means, if you are opting for a home loan while this repo rate is lower, you have to pay a lower interest rate and eventually affordable EMIs.
However, any change in the repo rate is at RBI’s discretion and depends on India’s prevalent economic atmosphere. Thus, individuals should also know some simple tips to secure lower interest rates on their home loans. Following are some of the tips that help in this regard.
- Borrowers should meet the lender-specific home loan eligibility criteria.
- Try to maintain a CIBIL score of 750 and above.
- Compare different lenders to get the most competitive interest rates.
- Existing borrowers can opt for a home loan balance transfer to save on interest payable.
- Choose a property that entails higher resale value.
Also check if you qualify for a pre-approved offer on a home loan. Various financial institutions extend such offers on products like a home loan and a loan against property to simplify the application process. Use your name and phone number to check your pre-approved offer.
The repo rate proves to be a major economic factor that governs the money market. Besides, this rate also impacts borrowers in terms of borrowing cost.